FIN 3030 CH7

What is the required return on a stock (RE), according to the constant dividend growth model, if the growth rate (g) is zero? RE = D0 − P1 RE = D0/P1 RE = D1/P0 RE = D0 + P1

RE = D1/P0

The formula for calculating the cost of equity capital that is based on the dividend discount model is _____.

RE = D1/P0 + g

The formula of the SML is ______. RE = Rf + β × (RM − Rf) RE = Rf − β + RM − Rf RE = Rf + β/(RM + Rf)

RE = Rf + β × (RM − Rf)

WACC is used to discount ______. political unrest common stock dividends cash flows news

cash flows

To estimate a firm's equity cost of capital using the SML approach, we need to know the _____. annual dividend amount market risk premium risk-free rate stock's beta

market risk premium risk-free rate stock's beta

The most appropriate weights to use in the WACC are the ______ weights. government-mandated salvage value book value market value

market value

The rate used to discount project cash flows is known as the______.

required return discount rate cost of capital

The WACC of a firm reflects the ______ and the target capital structure of the firm's existing assets as a whole.

risk

Including preferred stock in the WACC formula adds which term if P is the market value of preferred stock and RP is the cost of preferred? [P/(E + D)] × RP (P/V) × RP (V/P) × RP (V/P) × RP

(P/V) × RP

Which of the following is true about a firm's cost of debt?

It is easier to estimate than the cost of equity. Yields can be calculated from observable data.

What is the equation for finding the cost of preferred stock? RP = D/P0 RP = P0/D RP = D(1 + g)/P0

RP = D/P0

cost of preferred stock

Rp= D/P0

cost of equity

The return that equity investors require on their investment in the firm.

cost of debt

The return that lenders require on the firm's debt.

One of the most important concepts we develop is that of the weighted average cost of capital (WACC).

This is the cost of capital for the firm as a whole, and it can be interpreted as the required return on the overall firm.

True or false: RP = D/P0

True

Given V = E + D, if we divide both E and D by ___ we can calculate the capital structure weights

V or Value

What is the appropriate discount rate to use only if the proposed investment is a replica of the firm's existing operating activities? TC RD percentage of completion WACC

WACC

True or false: Finding the cost of equity is fairly straightforward.

False

True or false: The cost of capital depends on the source of the funds.

False

True or false: The discount rate is also known as the expected return.

False

If D is the market value of a firm's debt, E the market value of that same firm's equity, V the total value of the firm (E + D), RD the yield on the firm's debt, TC is the corporate tax rate, and RE the cost of equity, the weighted average cost of capital is ____.. [E/D] × RE + [D/E] × RD × (1 − TC) [(E + D)/E] × RE + [(E + D)/D] × RD × (1 − TC) [E/V] × RE + [D/V] × RD ×(1 − TC)

[E/V] × RE + [D/V] × RD ×(1 − TC)

Which of the following are components used in the construction of the WACC? cost of preferred stock cost of common stock cost of debt cost of accounts payable

cost of preferred stock cost of common stock cost of debt

The return an investor in a security receives is ______ the cost of the security to the company that issued it. greater than less than equal to unrelated to

equal to

Components of the WACC include funds that come from _____. accruals noncash expenses investors

investors

Finding a firm's overall cost of equity is difficult because _____. it can only be guessed at the federal government refuses to disclose equity costs it requires the use of differential equations it cannot be observed directly

it cannot be observed directly

The WACC is the minimum required return for ______. the overall firm the SEC a firm's bondholders a firm's stockholders the NYSE

the overall firm

True or false: The return an investor in a security receives is equal to the cost of the security to the company that issued it. True false question.

true

The cost of capital depends primarily on the ______ of funds, not the ______. use; source source; use use; cost source; cost

use; source

For a firm with outstanding debt, the cost of debt will be the ______ on that debt. coupon rate current yield yield to maturity average yield

yield to maturity